A presentation held by Professor Yu Yongding, Chinese Academy of Social Sciences and former member of the Policy Committee of the People´s Bank of China, at the high level seminar "Towards a sustainable financial system", hosted by the Stockholm based think tank Global Challenge in cooperation with London School of Economics and Swedish House of Finance on September 12th 2013.

1. The money supply and its
impacts in China
Yu Yongding
Institute of World Economics and
Politics, Stockholm 12 Sep. 2013

2. Is exogenous supply side policy the
applied format in China？
• “The dominant monetary theories between
the exogenous and endogenous creation of
money. While endogenous demand driven
creation has become the most accepted way
in Western countries, exogenous supply side
policy is the applied format in e.g. China.”
• Is the underlined proposition right? Not really.

3. the exogeneity of money supply
• the exogeneity of money supply is conditional
on
– the exogeneity of the monetary base and
– stability of the multiplier
• In China the two conditions for the exogeneity
of money supply cannot be met entirely.

4. The difficulty in controlling the
monetary base
• The expansion of China’s monetary base comes
overwhelmingly from the increase in foreign exchange
reserves
• The PBOC has to use sterilization policy to offset the
influence of the increase in foreign exchange reserves
on the monetary base
– selling CBBs
– raising RRR
– change benchmark interest rates of commercial banks
• The control over monetary base is passive, imprecision
in terms of timing and quantity, unstable, and causes
misallocation of financial resources

5. Instability of the monetary multiplier
• Pro-cyclicality
– When the economy is in deflation, the monetary
multiplier tends to fall (1998-2001)
– when the economy is overheating, the multiplier
tends to increase
• Unpredictability

6. Implications
• Because of the endogeneity of the money
supply, the PBOC has to give up targeting the
growth rate of broad money, even targeting
the credit
• Bench-market interest rates sooner or later
will become the intermediate target of the
PBOC

7. How has China’s monetary policy been
conducted?
• Growth rate of M2 is much higher than that of
nominal growth rate of GDP
• China’s inflation has been relatively low over
the past three decades
• China also experienced boom and bust cycles,
but fares much better than most EM countries

8. The exponential expansion of the
balance sheet of the PBOC

9. Rapid growth of monetary aggregates

10. The Highest M2-to-GDP ratio in the
world
Liability side of the banking system including the central bank liability, stock variable.

11. highest credit-to-GDP ratio in the
world
Asset side of banking system. Debt here is a
stock variable

12. the transmission from the money
supply to real GDP and inflation
• Compared with the endogeneity of the money
supply, the transmission failure from the money
supply to real economy is a more serious problem
facing the PBOC
– during and in the wake of the Asian Financial Crisis,
despite the fact that the growth rate of M2 is
significant higher than that of nominal GDP, both real
GDP and inflation refused to budge.
– In boom period, despite the monetary tightening, the
economy can still suffer from overheating. The
inflation and asset prices continue to rise

13. The chains of causality from the
monetary base to the real economy
• Monetary base money supply? real
economy and price
• Even if the supply of money is exogenous
variable, the availability of means of exchange
and store of value (nominal loanable funds) is
undecided, unless taking into consideration of the
demand of money, which seems not dependent of
the supply of money
• The missing link of the chains of causality is
social finance

14. Total Social finance
• TSF is a term coined by the central bank to monitor
aggregate financing apart from yuan bank loans. It is
a flow variable including RMB Loans, Foreign
Currency Loans (RMB), Credit Loans, Entrusted
Loans, Undiscounted Bankers' Acceptances,
Corporate Bonds, Domestic Equity Financing of
Non-financial Enterprises
• Failure in monetary targeting and credit targeting,
the pboc tries to use the so-called TSF as a reference
for the implementation of monetary policy

15. The decrease of the share of Bank
credit in “social finance”

16. The implication of the lowering of
share of credit in total social finance
• The share of bank loans in TSF fell from 91.9% in 2002 to
52.1% in 2012. Particularly in the last four months, the ratio
on average was less than 40%. In December, it was only 28%.
• the trend fits the goal of financial reforms to reduce the
economy’s excessive reliance on bank loans.
• What at issue is that the pricing of nonbank credit financial
products didn’t properly factor in the risk of the underlying
projects.
• This is especially related with shadow banking activities
• But the shadow banking activities still have some way to go to
cause a financial crisis

17. A puzzle: very high growth rate of the money
supply vis-à-vis relatively low inflation
• Growth rate of broad money is much higher
than that of nominal GDP persistently
• How can it be?
• What are the implications?

18. China’s inflation over time

19. China’s inflation over the past 30 years

20. China’s property price
Source: property China

21. A tentative answer
• High saving rate of the household sector
– Money is no just means of exchange
– But also store of value
– With a relatively underdeveloped capital market, saving deposits are the
dominant form of store of value
• Asset bubbles reduce the inflation pressure on the real economy
– When money is chasing assets rather than goods, inflation pressure will be
reduced, ceteris paribus.
– House price growth Is extreme fast. House essentially is a durable good. If
property prices have been incorporated in CPI after some adjustment, China’s
inflation could be much higher.
• In taking off stage, a relatively high growth rate of money supply is
reasonable. But following the maturity of the economy, it is no longer
true.
• But, loose monetary policy allows leverage to increase excessively, the
high leverage increases the likelihood of financial crisis